Fed move: More trouble for bond investors?

Continuation of its bond-buying program may further crowd fixed-income market

By

JonnelleMarte

The Federal Reserve on Wednesday said it will extend its bond-buying program into the new year in an effort to accelerate economic growth. But advisers say the action will also come with a downside for bond investors — fewer safe places to hide.

Getty Images

WASHINGTON, DC - DECEMBER 12: Federal Reserve Chairman Ben Bernanke holds a press conference following a Federal Open Market Committee meeting at the Federal Reserve Bank headquarters December 12, 2012 in Washington, D.C. The Federal Reserve announced it would continue its monthly purchase of $85 million in Treasury bonds and mortgage-backed securities until the outlook for the labor market improves. (Photo by Chip Somodevilla/Getty Images)

The Fed said it will buy $85 billion a month in long-term Treasury bonds and mortgage-backed securities next year. The latest stimulus will replace the “Operation Twist” program, in which the Fed has been buying about $45 billion of long-term Treasurys each month and selling the same amount of short-term Treasury bonds.

For income-seeking bond investors already concerned about rock-bottom yields, the latest extension will leave even fewer options, say advisers. By making larger purchases of Treasury and mortgage bonds, the Fed may not only shrink yields on those types of bonds (yields drop when prices rise), but in other parts of the bond market, says Sam Katzman, chief investment officer for Constellation Wealth Advisors in New York City. For example, investors may pile into riskier bonds like corporate or emerging-market debt, pushing their yields down further. “The Fed is making it almost impossible to be a bond owner,” says Katzman.

The move comes as investors continue to choose bonds over stocks, despite record-low interest rates. Since January 2009, investors have yanked an estimated $275 billion out of stock funds and poured $1 trillion into bond funds, according to the Investment Company Institute.

Still, advisers recommend clients continue to own bonds — but to pick their spots. For instance, Brian Rehling, chief fixed income strategist for Wells Fargo Advisors, is cutting back on high-yield bonds and emerging-market debt, and adding more investment-grade-corporate bonds, which carry less default risk. Ken Taubes, chief investment officer at Pioneer Investments, says investors should consider turning to floating-rate securities, which have rates that adjust with the overall bond market. If rates rise, the yields on these bonds should also rise.

Another option, says Taubes: Convertible bonds. Once a company’s share price reaches a certain level, investors can swap these bonds for stocks, which could have greater long-term returns, he says. In many cases, convertible-bond investors could wind up boosting their income either way, since many companies are paying dividend yields that are higher than the yields on Treasurys or their own corporate bonds.

If the Fed increases the total amount of bonds it buys beyond $85 billion a month — Chairman Ben Bernanke said in a news conference today that amount would be adjusted if needed — investors should consider investing more heavily in industrial metals like copper, alloy and nickel and alloy, says Charlie Smith, manager of the Fort Pitt Capital Total Return fund. Those metals should rise in value, along with gold, if the dollar weakens and investors become more worried about inflation, he says.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.